Last December after being chosen by Donald Trump to be Treasury secretary, Steve Mnuchin was interviewed on CNBC. He had this to say about Trump’s tax cut: “Any reductions we have in upper-income taxes will be offset by less deductions, so that there will be no absolute tax cut for the upper class.” Some commentators called this statement the “Mnuchin Test” for any tax plan.
Recently Treasury Secretary Mnuchin said that President Trump’s tax plan will “pay for itself.” In government parlance a tax cut is called a “tax expenditure.” Cutting taxes is like spending tax dollars on a government purchase except the dollars go to the taxpayer. The cost of a tax cut is the amount by which it reduces revenues. What Mnuchin said was that Trump’s plan will not reduce revenues.
It became clear when Mnuchin rolled out Trump’s one-page tax plan on Wednesday why he said it would pay for itself. He believes this plan will spur economic growth, increase hiring and collect more revenue from businesses and individuals to offset the revenue lost by cutting taxes. Needless to say, if that were true all politicians would want to cut taxes. More jobs mean happier voters.
Mnuchin did not provide enough details to fully evaluate this plan. Still, most experts have opined that it would greatly favor the wealthy and thereby violate the Mnuchin Test. And some thought it would increase deficits by as much as $5 trillion over 10 years. In my opinion it was a publicity stunt and not a serious proposal that deserves careful analysis at this time.
My research indicates that there is only one type of tax policy that arguably pays for itself and it is not a direct cut in taxes. Rather it is a deduction that allows small businesses to offset income by the expense of up to $500,000 in new equipment purchased. In effect this reduces the company’s taxes while the purchase of equipment enhances economic growth and creates jobs. This tax policy creates a direct correlation between the burden of revenue lost and the benefit of increased economic activity. House Speaker Paul Ryan’s tax plan includes this type of provision; Trump’s doesn’t.
On the other hand when tax rates are reduced for individuals or corporations it is difficult to predict what the beneficiaries will do with the extra money. Individuals may put it in savings or invest it in China. Corporations may increase dividends, buy back stock or invest in China. Consequently the effect on the U.S. economic activity is far from certain.
Meanwhile, at the other end of Pennsylvania Avenue, Speaker Ryan has his own ideas on tax reform. He proposed a border adjustment tax that would put a 20 percent tariff on imports and provide an additional $1 trillion in revenue over the next 10 years. This extra revenue would offset the revenue lost by reducing rates on individuals and corporations. Ryan wants to insure that any tax plan passed by the House is revenue neutral so that it doesn’t increase deficits.
Why is revenue neutral important? Well, Republicans want to pass their tax plan in the Senate with a simple majority vote via reconciliation and avoid a filibuster that would require 60 votes. They also want their plan to be permanent. In order for reconciliation legislation to be permanent, the Senate rules require that its provisions not increase deficits beyond 10 years. Revenue neutral tax reform complies with these rules.
Ryan knows that Trump’s plan to lower the top corporate tax rate from 35 percent to 15 percent would result in increased deficits beyond 10 years, which would prevent it from being permanent. But Mnuchin doesn’t seem to be concerned about that; he thinks a tax cut that only lasts 10 years like those of President George W. Bush is better than no tax cut. This had to frustrate Ryan to no end.
But adding to the deficits is a problem. The Congressional Budget Office is currently projecting a deficit of $9.5 trillion over fiscal years 2018 through 2027. Even if Republicans achieve a revenue neutral tax reform, the deficit projections will not change. Consequently, in order to achieve the GOP goal of a balanced budget, federal spending must be drastically cut.
How much would spending have to be cut? Well, if the entire defense budget of $6.87 trillion were eliminated there would still be a 10 year deficit of over $2.6 trillion. And if the entire budget for nondefense discretionary spending that funds the rest of the government were eliminated there would still be a deficit of $3.38 trillion.
If Trump gets his way with taxes, deficits will almost certainly increase; plus he wants billions of more spending for defense and $1 trillion for infrastructure. Republicans in Congress love tax cuts and military spending but they also want a balanced budget. Needless to say balancing the budget with Trump’s agenda will be impossible without draconian cuts to the mandatory spending programs like Medicare, Medicaid, Social Security and other so-called entitlements.
During President Obama’s administration Republicans made bold claims about turning Medicare into a premium support system and cutting entitlements. Now they finally have a Republican president and control of Congress. The question is, will they put their legislation where their mouth is?
I’m betting that they won’t have the political courage to do it.